Page 382 - How to Make Money in Stocks Trilogy

When to Sell and Take Your Worthwhile Profits 257

Jesse Livermore and Pyramiding

After reading his book, I adopted Livermore’s method of pyramiding, or
averaging up, when a stock advanced after I purchased it. “Averaging up” is
a technique where, after your initial stock purchase, you buy additional
shares of the stock when it moves up in price. This is usually warranted
when the first purchase of a stock is made precisely at a correct pivot, or buy,
point and the price has increased 2% or 3% from the original purchase
price. Essentially, I followed up what was working with additional but
always smaller purchases, allowing me to concentrate my buying when I
seemed to be right. If I was wrong and the stock dropped a certain amount
below my cost, I sold the stock to cut short every loss.
This is very different from how the majority of people invest. Most of
them average down, meaning they buy additional shares as a stock declines
in price in order to lower their cost per share. But why add more of your
hard-earned money to stocks that aren’t working? That’s a bad plan.

Learning by Analysis of My Failures
In the first half of 1961, my rules and plan worked great. Some of the top
winners I bought that year were Great Western Financial, Brunswick, Kerr-
McGee, Crown Cork & Seal, AMF, and Certain-teed. But by summer, all
was not well.
I had bought the right stocks at exactly the right time and I had pyra-
mided with several additional buys, so I had good positions and profits. But
when the stocks finally topped, I held on too long and watched my profits
vanish. If you’ve been investing for a while, I’ll bet you know exactly what
I’m talking about. It’s a problem you must tackle and solve if you want real
results. When you snooze, you lose. It was hard to swallow. I’d been dead
right on my stock selections for more than a year, but I had just broken even.
I was so upset that I spent the last six months of 1961 carefully analyzing
every transaction I had made during the prior year. Much like doctors do
postmortem operations and the Civil Aeronautics Board conducts postcrash
investigations, I took a red pen and marked on charts exactly where each buy
and sell decision was made. Then I overlaid the general market averages.
Eventually my problem became crystal clear: I knew how to select the
best leading stocks at the right time, but I had no plan for when to sell them
and take profits. I had been completely clueless, a real dummy. I was so
unaware that I had never even thought about when a stock should be sold
and a profit taken. My stocks went up and then down like yo-yos, and my
paper profits were wiped out.